2/02/2009 @ 3:00AM

Outsourcing's Big Picture

Outsourcing is no longer just about cheap labor. The number of foreign-educated students returning to their native countries is exploding, creating an offshore talent pool of highly trained workers that never existed before.

It’s also no longer just about India and China. Globalization is catching on almost everywhere, creating competition even in the most highly skilled professions and raising the competitive stakes everywhere. The silver lining is that it’s also opening new markets that seemed unlikely even five years ago.

Forbes caught up with Robert Kennedy, director of the Global Initiative at the University of Michigan’s Ross School of Business.

Forbes: What’s driving outsourcing on a macro level?

Robert Kennedy: There are five key drivers. One is a tremendous liberalization on the policy side. In the mid- to late-1980s, the global economy consisted of the U.S., Europe and Japan. Places like India and China were behind Central and Eastern Europe and parts of Africa. They weren’t really engaged in the global economy. That’s completely changed. Roughly 3 billion people have entered the global economy. They want to buy things, and in order to do that, they have to sell something back to us. They can sell us manufactured goods, and they have a small advantage there. But in services, they have a huge advantage. If you move an automobile manufacturing plant from Michigan to Mexico, you may save 20%. If you move a call center offshore, once you’ve set it up on a run-rate basis, you’ll save 50% to 60%. The advantage in services is that labor costs are a bigger overall percentage.

Does that mean China ultimately will move to head-to-head competition with India?

No, China is pretty far behind India and even places like the Philippines and Eastern Europe. It’s largely due to a language problem. There are real challenges. Services exports from China will grow, but they won’t overtake India anytime soon.

What’s the second driver?

The digitization of business processes. Twenty years ago most business records, with the exception of accounting, were kept in manual form. Once all business critical records are electronic, location is irrelevant. Software relationship management records, call records and accounting records are all electronic. Even contracts are scanned and stored electronically.

Perot Systems has a huge claims processing operation in India. They work with dozens of insurance companies to process paperwork for doctors’ offices. It gets scanned locally and then goes to a place like Perot where they have people looking at the paperwork the doctor filled out. They match it up with your insurance policy, figure out what’s covered and what the co-pay is and where you are in your coverage for the year. They have hundreds of people key-punching this stuff. In the past it was done by middle-income Americans, but now it’s done by middle- or high-income Indians. That leads into the next trend, which is the low cost and high speed of computing and telecom. Bandwidth is cheaper, and international calls are cheaper.

How about the other trends?

There is a global pool of talent around the world. There is a lot of engineering talent in India and China, which leads to the last trend–the rise of a global business culture. If you went to Brazil or South Africa 20 years ago, things looked very different. Now 30% of the MBAs at U.S. schools are international, and they’re going home after they get their degrees. They used to come to school in the U.S. and stay here. These countries have liberalized since then. They’ve got their own venture capital groups and start-ups. That really closes the cultural gap. It’s much easier for someone at Citibank or AIG to do business in India if they’ve been to the same schools and they use the same software like PeopleSoft. That’s made it much easier to go abroad, as well.

How long has this been going on?

I’ve been at Michigan five years. Prior to that I was at Harvard Business School, and the question I looked at there was, “Where were the students five years out?” It wasn’t so much what their first job was when they graduated. When I looked at the class of 1980 from developing countries, only 20% were working in their home region after five years. For the class of 1990, it was up to 38%. For the class of 2002, 56% were back in their home region. In 1980, if you were a Harvard M.B.A., there weren’t a lot of interesting jobs for you in India or Brazil. The place to go was here or Europe. Now if you’re in India with an M.B.A., there are numerous interesting jobs for you, and a lot of them pay as much as here–sometimes even more.

Is that a function of cost of living differences?

Not always. Companies like IBM and some of the large consulting firms are not discounting salaries in developing countries. IBM is growing aggressively in India. It has about 70,000 people there now, and it has an incredible need for good management talent. Even though it’s cheaper to live there, IBM has to induce people to go there. They pay equal or a premium.

So given all this, is this good or bad for the United States?

That’s an interesting question. Personally, I think that while it’s disruptive in the short term, in the long term it’s actually good. Even if you think it’s bad–and that’s not my position–the question is what can the U.S. government possibly do about it? If you don’t like the fact that auto parts get built in Mexico or China, it’s pretty easy to stop trucks from crossing the border or stop ships from pulling into Los Angeles harbor–or you put a tariff on them. But if the government doesn’t like the fact that General Electric does all of its accounting worldwide out of a couple accounting centers in India, there’s very little it can do.

It’s not even that clear which jobs are being displaced. If you shut an assembly plant in Michigan and move 500 jobs to Mexico, it’s pretty obvious what has happened. On the other hand, GE is hiring people in India and laying off people two years later in a different group in the United States–often in twos or threes. It’s incredibly hard to observe and identify. In addition, the U.S. government can’t stop companies from putting tasks in the places where they can be done best. That’s what this is all about. Companies are looking for the best combination of talent and cost.

Is there anything that could offset these trends?

Only government policy. But there are about 200 countries in the world, and about 150 of those are developing countries. If you look out over the next five years, 90% will be open to the global economy. There are always some backsliders, like Venezuela and Zimbabwe, and North Korea has never moved forward. The rest all have Internet connections. They’re investing in technical and higher education. That means the network of service providers around the world will be denser, and there will be more opportunities. A decade ago, if you wanted to cut costs it was an India story. We identified 30 countries that have policies in place to promote service exports. All of the parking tickets in New York City are processed in Ghana. It won’t be one country that will knock India off the top. It will be a lot of small countries.

Robert Kennedy is the author of The Services Shift, a new book on off-shoring.